By Tom Petruno
July 4, 2015
The last six years of extraordinarily low interest rates have been all about rewarding borrowers at the expense of savers. But that is probably coming to an end.
If the Federal Reserve begins raising short-term rates by year’s end, as anticipated if the economic expansion continues, the costs of many forms of debt will rise from current super-cheap levels.
The increases probably would be modest at first, tracking what’s expected to be a go-slow policy by the central bank. Still, any boost in borrowing costs would be painful for indebted consumers and small-business owners who have suffered meager income growth in recent years.
U.S. consumer debt other than home loans hit a record $3.38 trillion in May, Fed data show.
Although the debt load fell initially during the 2008-09 financial crisis, it quickly began to rebound, paced by student and car loans.
Nowhere to go but up
For many Americans, debt is affordable and makes sense at these low rates. But now’s the time for borrowers to look at what they owe and figure out how much their interest costs will rise if the Fed begins to lift rates, said Greg McBride, chief analyst at rate research firm Bankrate Inc. It’s far better to plan than to face sudden payment shock.
The best strategy in the face of higher rates is to pay down debt, if possible. Barring that, there are other ways to make rising rates easier to bear.
Here’s a look at the most common consumer and small-business borrowing tools and what to expect once the Fed begins to lift rates:
•Credit cards: Plastic debt typically is the most expensive debt, and it will get more so with every Fed rate increase. That’s because “the vast majority of cards are variable-rate now, not fixed-rate,” said Matt Schulz at online card marketplace CreditCards.com. Variable-rate cards charge floating interest rates that are pegged to short-term market rates — most often, to banks’ so-called prime lending rate.
The prime, in turn, takes its cue from the Fed’s benchmark short-term rate, known as the federal funds rate. The Fed has held the federal funds rate near zero since the financial crisis deepened in December 2008. Banks’ prime rate has been at 3.25% since then.
If the Fed raises the federal funds rate to 0.25%, banks are expected to quickly lift the prime rate to 3.50%. Credit card rates generally should rise by 0.25 percentage point as well, and continue to move up in tandem with any successive Fed increases.
Consumer debt at new high
Card rates currently average about 15% nationwide, though people with bad credit can pay 22% or more, according to CreditCards.com. So as a percentage of what borrowers already are paying on outstanding debt, a few quarter-point Fed boosts won’t add much. Still, if you’re carrying a balance on your card, consumer finance experts advise checking the fine print so you’re aware exactly how much your rate will rise.
This also is a good time to consider finding a better card deal, McBride said. For example, if you have a large card balance, some issuers will allow you to transfer it to their card and pay zero interest on the balance for a set period, sometimes a year or longer. That could add up to a lot of interest savings, particularly if card rates start rising quickly.
•Home equity credit: Loans secured by the equity in a home also tend to be pegged to banks’ prime rate. Many home equity loans now charge annualized interest of 6% to 8%, according to Bankrate.com. If the prime rises, home equity loan rates will match those increases.
The advantage of these loans over other credit is that the interest is tax deductible, just like mortgage interest. So using equity loans to pay off other debt has long made sense.
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